The IRS recently issued proposed regulations (REG-108761-22) that would make certain charitable remainder annuity trusts (CRAT) a listed transaction. The proposed regulations, released on March 22, 2024, would affect both taxpayers and material advisers, but organizations whose only role was as a charitable remainderman would not be treated as participants.
Traditionally a CRAT is established by a taxpayer to receive a gift of an appreciated asset. The taxpayer retains an annuity interest in the trust for a term of years or the life of the taxpayer. The trust then sells the appreciated asset that was gifted to the trust. The trust does not pay any taxes currently on the sale of the asset. However, the annuity distributions from the trust are taxable to the taxpayer when received from the trust. In a CRAT, the distributed annuity amount comes out of the trust, and that distribution is characterized by the income that the trust has accumulated. Ordinary income from the trust is counted first, then when ordinary income is exhausted, accumulated capital gains is recognized, then tax-exempt income and finally a return of the basis of the asset. At the end of the annuity term, the assets of the trust are distributed to a charitable organization.
The IRS believes certain taxpayers and promoters have tried to avoid the taxation of the distributions out of the GRAT with aggressive interpretations of the rules governing GRATs that are not supported by the statues governing the taxation of GRATs and their beneficiaries. The first transaction is one where the CRAT sells the appreciated property that was transferred to the CRAT and uses the proceeds to purchase a single premium immediate annuity. The beneficiary of the trust treats the annuity distributions from the trust as being an annuity payment subject to Section 72, rather than carrying amounts of ordinary income and capital gain tiers in accordance with the CRAT provisions of Section 664(b). Additionally, taxpayers are treating the transfer of the appreciated property to the CRAT as giving the assets a step up in basis to FMV as if they were sold to the trust. The IRS rejects all these interpretations of the relevant tax law and is proposing to define these transactions as listed transactions.
The proposed regulations go on to provide that an organization described in Section 170(c) that is designated as the charitable remainder recipient will not be treated as a party to the listed transaction solely by reason of its status as the charitable remainderman.
Grant Thornton insight
Taxpayers should assess CRAT transactions for similarity to the transactions identified in the new IRS rules. Participation in the CRAT listed transaction can lead to severe penalties to the taxpayer and their advisors.
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